STRUCTURED FINANCE AND CAPITAL RAISING: HOW LEGAL FRAMEWORKS IMPACT DEAL STRUCTURING IN AFRICA
I. INTRODUCTION
In 2018, an ambitious infrastructure project in East Africa aimed to raise more than $500 million to create a regional transit hub. The deal was structured using a combination of debt financing, sovereign guarantees, and private equity investment. However, just as the project was gathering steam, legal issues pertaining to taxation, cross-border rules, and the enforceability of security interests stalled negotiations for almost two years. By the time they arrived at a resolution, investor confidence had dropped significantly, and the deal had to be restructured entirely.
Situations of this nature are not unfamiliar to Africa’s dynamic yet legally intricate financial landscape. Structured Finance and Capital Raising are key mechanisms for funding large-scale projects, expanding businesses, and unlocking economic potential. However, the success or failure of these deals often hinges on the legal framework governing them. In this article, we will break down structured finance and capital raising in Africa, explain key financial instruments, explore regulatory frameworks, and highlight the challenges investors and businesses face.
II. WHAT IS STRUCTURED FINANCE?
Structured Finance is a sophisticated financial tool designed to address the unique needs of investors and borrowers, especially in situations where conventional financing techniques might not be sufficient. Simply put, it is a specialized way of raising capital, particularly when traditional loans do not work. Rather than relying solely on traditional lending, it involves a process of pooling assets—such as real estate, future cash flows, or loans—into securities that investors can buy. This strategy is very important in Africa, where access to credit can be limited as a result of perceived risks and regulatory uncertainties. Think of Structured Finance like building a bridge. Rather than rely on a single pillar (one lender), the bridge is supported by multiple pillars—different financial instruments—spreading the risk and making it easier to access large sums of money.
COMMON STRUCTURED FINANCE MECHANISMS IN AFRICA
1. Securitization Structures:
Securitization is the financial process of taking difficult or impossible assets to exchange, and then transforming them into marketable securities that investors can trade. In securitization, the company (or the originator) that holds the assets determines which assets to remove from its balance sheets, freeing up funds to issue new loans. Investors profit by earning returns from the payments borrowers make on these loans. There are different types of securitization structures, with the primary ones including:
a. Asset-Backed Securities (ABS): These are a class of financial instruments that are secured by a pool of underlying assets, typically those that produce cash flow from debt, including receivables, credit card balances, leases, or loans. It takes the form of a bond or note and pays income at a fixed rate for a set amount of time, until maturity. The underlying assets of an ABS are often illiquid and cannot be sold on their own. So, pooling assets together and creating a financial instrument out of them—a process called securitization—allows the issuer to make illiquid assets marketable to investors.
b. Collateralized Loan Obligations (CLOs): These are structured finance securities backed by a pool of corporate loans. Investors who buy CLOs receive payments from borrowers but also shoulder the risk if the borrowers default. CLOs are divided into different tiers, referred to as “tranches,” which determine how investors are paid. There are two types of tranches- Debt tranches, also referred to as mezzanine tranches, are treated just like bonds and have credit ratings and coupon payments. They come first in the order of repayment. Equity tranches, on the other hand, do not have credit ratings and are often paid after all debt tranches. They are rarely paid after a cash flow but do offer ownership in the CLO itself in the event of a sale. Also, they often receive higher returns than debt tranche investors because they usually face higher risks.
2. Special Purpose Vehicles (SPVs)
A Special Purpose Vehicle (SPV), also called a Special Purpose Entity (SPE), is a separate subsidiary created by a parent company to isolate financial risk. Its legal status as a separate company makes its obligations secure should the parent company suffer bankruptcy, making it a secure way to manage investments. SPVs are usually created to securitize or isolate assets in separate businesses that are typically kept off the balance sheet. It can be used just to separate risky projects, protect assets, and ensure investors are repaid. Its operations are limited to the acquisition and financing of specific assets in any case. Governments and Corporations in Africa largely use SPVs for project financing, Public-Private Partnerships (PPPs), and infrastructure development, helping them reduce financial risks and comply with regulations.
KEY CAPITAL RAISING METHODS
1. Debt Capital Markets (DCM)
Debt Capital Markets (DCMs) refer to the financial system that enables the issuance, distribution, and trading of various debt instruments. When companies and governments need funds, they can sell these debt securities to investors, promising to repay them with interest over time. DCMs combine investment banking and trading of bonds, which makes them a go-to option for organizations that need quick cash inflow. In Africa, nations like Nigeria, South Africa, and Egypt have successfully issued Eurobonds, attracting international investors looking to invest in emerging markets.
2. Private Equity (PE) & Venture Capital (VC)
While both Private Equity and Venture Capital have to do with investing in companies in exchange for ownership, they operate differently. Private Equity refers to investments where capital is pooled from investors to acquire equity ownership in private companies or public companies that are delisted from stock exchanges. High-Net-worth Individuals (HNIs) and companies invest in these ventures, occasionally even acquiring publicly traded companies to take them private. Restructuring and expanding the company before selling it for a profit is frequently the goal.
Venture Capital, on the other hand, focuses on funding start-ups and small enterprises with high growth potential—especially those bringing innovation or creating new markets. This kind of finance is typically provided by specialized venture capital funds, investment banks, and affluent investors. The investment need not be monetary; it can also be made through management or technical know-how.
3. Project & Infrastructure Financing
Project finance refers to the phrase used to describe the funding of long-term infrastructure and industrial projects, especially in the transportation, power production, and Oil & Gas industries. Rather than using the company’s own balance sheet, the project itself is set up using a separate entity (called SPVs) that manages its funding. The loans taken out for that project are paid back using the money generated by the project, rather than relying on the company’s finances. This approach holds particular appeal because it allows companies to take on huge projects without affecting their financial stability or borrowing capacity. Some of the common sponsors of project finance include: construction companies, financial institutions, industry players, and public sector sponsors.
III. LEGAL AND REGULATORY FRAMEWORKS GOVERNING STRUCTURED FINANCE IN AFRICA
Structured Finance plays a key role in raising funds for infrastructure projects, precisely in developing countries. That being said, these transactions must conform to some legal and regulatory frameworks that influence how these deals are structured. These frameworks can be grouped into the following:
a. Local Regulatory Authorities: Each country in Africa has its own financial regulatory body that oversees its securities markets to protect investors and ensure transparency. In Nigeria, the Securities and Exchange Commission [SEC] regulates capital markets under the Investment and Securities Act [ISA]. In South Africa, the Financial Sector Conduct Authority [FSCA] regulates financial instruments, including structured products and derivatives. For Kenya, the Capital Markets Authority (CMA) oversees securities transactions and enforces listing requirements.
b. Central Banks: They play a key role in monetary policy and financial stability. They regulate financial institutions that engage in structured finance transactions and ensure compliance with prudent requirements.
c. Regional Legal Frameworks: Some African countries operate under unified legal frameworks that harmonize business and financial regulations across jurisdictions. An example is the OHADA (Organization for the Harmonization of Business Law in Africa) which governs commercial law in 17 Francophone African countries. Another example is the Economic Community of West African States (ECOWAS).
d. Global Regulatory Standards: African countries must also adhere to global regulatory standards such as those set by The Basel Committee on Banking Supervision and The Financial Action Task Force (FATF) that established anti-money laundering and counter-terrorism financing measures.
IV. CHALLENGES HINDERING STRUCTURED FINANCE GROWTH IN AFRICA
While structured finance is a structured tool for funding infrastructure projects in Africa, several legal and financial challenges stall its progress. They include:
a. Regulatory Ambiguity: In Africa, the complexity of structured finance transactions may not be sufficiently addressed by current legislation. The lack of clear and comprehensive legal frameworks to govern structured finance transactions makes private investors hesitant about committing funds due to uncertainty about how their investments will be protected.
b. Weak Enforcement Mechanisms : Even where there is the existence of these regulations, enforcing contracts and resolving financial disputes emanating from structured finance transactions can prove difficult. In many countries, the judiciary lacks the necessary resources or expertise to effectively handle intricate financial disputes. This makes potential investors wary of possible future risks.
c. Cross-Border Legal Complexities: Structured finance, in some cases, often involve multiple countries with different legal and regulatory systems. Where this is the case, these inconsistences can create delays, increase costs, and complication the execution of the project.
d. Currency and Foreign Exchange (FX) Challenges: Lastly, currency depreciation, and foreign exchange (FX) restrictions in many African markets pose significant risks for investors. Unstable exchange rates can erode investment returns and make capital restructuring more difficult.
The above-mentioned legal challenges affiliated with structured finance in developing countries greatly impact infrastructure development. To tackle these challenges, governments can begin by addressing regulatory ambiguity, strengthening enforcement mechanisms, streamlining cross-border procedures, and implementing effective currency stabilization mechanisms, such as hedging instruments and swap agreements. By putting these tactical measures in place, governments can foster an atmosphere that encourages long-term private investment and sustained economic growth.
V. IMPACT OF LEGAL FRAMEWORKS ON DEAL STRUCTURING
The impact of legal frameworks in shaping how structured finance deals are designed and executed can be seen in several key areas. Some of them include:
a. Investor Confidence and Legal Clarity: A clear and predictable legal framework promotes investor confidence by guaranteeing the enforceability of contracts, protection of property rights, and clarity of dispute resolution procedures. Countries like South Africa and Rwanda with strong judicial systems, offer legal protections that boost investor confidence. On the other hand, in jurisdictions with weak judicial systems and drawn-out legal proceedings like Nigeria and Angola, investors may demand greater risk premiums to offset uncertainties.
b. Debt and Equity Structuring: The legal systems greatly determines how companies secure funding through debt or equity. Regulations on securitization, syndicated loans, and bond issuance vary across Africa. For instance, Nigeria’s Investment and Securities Act (ISA) 2007 governs debt securities, while South Africa’s Companies Act and Financial Markets Act of 2012 offer a comprehensive framework for issuing corporate bonds.
c. Risk Allocation and Protection: Well-defined laws help manage financial risks including defaults, insolvency, and currency fluctuations offer safeguards against default, insolvency, and exchange rate fluctuations. Many African countries impose foreign exchange controls, impacting how investors repatriate returns.
d. Regulatory Compliance/Governance: Deal structuring is largely influenced by compliance requirements such as licensing, financial reporting and corporate governance standards. These help ensure transparency and stability but can also add layers of bureaucracy that investigators must navigate
VI. COMPARATIVE ANALYSIS: AFRICA VS. OTHER JURISDICTIONS
The regulatory frameworks governing structured finance differ across separate regions. This fact has a considerable impact on the effectiveness and accessibility of financial instruments designed for infrastructure projects. For instance, in Africa, the regulatory environment is still characterized by a mixture of modern legislation and traditional legal frameworks. Countries like South Africa and Kenya have made significant progress with clear guidelines for asset-backed securities and project finance. However, in many parts of the continent, outdated laws, regulatory overlaps, and foreign exchange restrictions still pose difficulties for investors.
South Asia, on the other hand, have differing levels of regulatory development. India has made significant progress through the implementation of reforms like the Insolvency and Bankruptcy Code of 2016, which has boosted investor confidence in infrastructure financing. However, bureaucratic inefficiencies and regulatory inconsistencies still hinder broader financial inclusion across the region. In the meanwhile, the structured finance regulations of Latin America demonstrate a blend of creativity and difficulty. A notable example is Brazil which sticks out for its sophisticated legal system that encourages public-private partnerships and investor participation through transparent regulations. However, countries like Venezuela still struggle with unstable political and economic environment which has made structured finance difficult to sustain.
Furthermore, currency stability and repatriation of profits are major concerns for foreign investors in African markets. Developed countries like the U.S., EU, and Singapore, have minimal restrictions on foreign capital transfers, making them more attractive to international investors, In Africa however, strict foreign exchange controls in some countries can disrupt structured finance transactions.
VII. CONCLUSION
Structured finance is a powerful tool for driving Africa’s economic growth, but its success or otherwise depends on strong, clear, and enforceable legal frameworks. The governments of nations must give priority to investor-friendly regulations, financial regulations should push for reforms that reduce bureaucratic red tape, and business must stay informed to navigate the evolving financial landscape. With a proactive approach to legal and regulatory improvements, Africa will be well-positioned to unlock new funding opportunities, boost infrastructure, and foster long-term economic stability. The key is collaboration between, governments, investors, and financial/regulatory experts to build a structured finance system that works for everyone.
